Every time a popular tech name doubles on the first day it is publicly traded, journalists write articles about how it left too much money on the table. Today it was no different with Twitter, so I tweeted the following.
Nov. 7 at 1:07 PM
I received several requests to elaborate on my words, so here it is.
Twitter sold 70mm shares at $26 and raised $1.8bn. Just because the price opened at 45 and closed there, some assume that Twitter left money on the table and should’ve raised the price. Non-sense.
First, you have to remember that IPOs are means to an exit strategy. Every private company is owned by its founders, management, employees and VCs. Before a company goes public, its Board of Directors issues shares to the entity (in this case Twitter Inc.). Most of entity’s shares are offered to the public via an IPO. The rest of the shares are owned by the mentioned insiders, but they are restricted to sell them in the next 6 to 12 months after the IPO.
Twitter sold 70mm shares out of 575mm shares outstanding, which means that its current float (number of shares available to trade) is 70mm shares. Its restricted shares (owned by Twitter’s insiders) are 505mm and they will become available to trade within the next year.
There is a reason only a small percentage of each new public company’s shares outstanding is offered – to limit the supply in order to maximize the market valuation of that company. Do you really think that Twitter would’ve got $26 a share if it sold 500mm shares?
Investment banks do a serious research in order to figure out the demand. It is often an educated guess based on extensive experience of underwriting IPOs. They have two clients – the private owners of company that is going public (usually one-time customers) and institutions that buy the IPO allocations (repeat customers). Guess which interests they are trying to cater to more?
What would’ve happened if Twitter raised its IPO price to $40? First of all, the odds are that at $40 it would have been under-subscribed or it would have become a second “Facebook”. We all remember Facebook’s fiasco from May 2012, which basically closed the doors for new IPO deals for months to come. Facebook raised a little bit more money, but as a result everyone suffered. Retail investors and institutions were burned, investment banks lost business, employees were able to sell at a lot lower prices 6 months later as Facebook’s stock was crushed.
When a stock performs outstanding in the months after its IPO, it provides a huge window of opportunity for secondary offerings – where in most cases, insiders sell their restricted shares ahead of schedule. This is their exit, this is their pay-day.
Institutions are lot more willing to buy the secondaries of stocks that gained after their IPO. Secondaries are often a necessary evil. They are organized transfers of ownership that helps to smooth out insider selling that will happen anyway.
Lastly, for the IPO market to continue to work in long-term perspective and deliver the current absorbitant valuations, you have to leave some meat on the bones for the public. Nowadays, most of the wealth is created for the founders, VCs and early employees. Companies go public a lot later in their growth cycle, when they already have serious international exposure and as a result demand higher valuation.